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Can Barnes & Noble Survive Another Year?

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If you were to read Barnes & Noble's (NYSE: BKS  ) 2011 shareholder letter, you'd be excused for thinking the company is doing great. Chairman Len Riggio characterized its year as remarkable, heaped praise upon the company for being "one of the world's fastest growing providers of digital content," and claimed that the "numbers speak for themselves" when discussing the bookseller's digital strategy.

 An independent examination of the numbers, however, reveals a company on the brink of illiquidity and insolvency. And to make matters worse, the lion's share of its business is a proverbial albatross -- namely, its 700 brick-and-mortar bookstores -- making the bookseller an unlikely takeover target despite the value of its digital division. Indeed, as much as it pains me to say this, for the reasons I discuss below, it's not so much a question of if B&N will perish, but when.

Looking beyond the rhetoric
B&N's financial statements disclose a number of startling truths about the company's fiscal health. The company is burning through cash. It reported a combined negative free cash flow of nearly $400 million in the last two quarters alone, and it possessed a mere $24 million in cash at the time of its last filing, as well as $275 million in long-term debt. And to top things off, it hasn't turned a profit in the most recent four quarters.

Although the company probably had a respectable holiday season in light of Borders' recent demise, its same-store sales have been abysmal over the last few years. In fiscal 2007, its retail division recorded $4.8 billion in sales. In fiscal 2011, on the other hand, its sales were less than $4.4 billion. While the company closed a handful of stores in the intervening period, the vast majority of this 9% decline is attributable to organic deterioration. And unlike other retailers that have stanched the bleeding from the economic downturn, B&N continues to suffer. In its most recent quarterly filing, its same-store sales decreased by an additional 0.6% -- and that was without Borders in the picture!

The company's gross margin has also deteriorated markedly over time. The significance and explanatory power of this metric cannot be overstated. It's a quantitative barometer of brand and pricing power. As such, companies like Apple and lululemon athletica regularly record gross margins in excess of 40% and 50%, respectively. These two brand darlings can thus command above-market prices with ease and thus generate more revenue per dollar of sales.

A company with low and/or declining gross margins alternatively is a cause for concern. And this is the situation that B&N finds itself in. After years of recording gross margins of 30% or higher, its recent margins have settled around 25%. It can be assumed that this is the result of competition from the likes of, which can sell books for less due to its distribution model with less overhead.

At the end of the day, B&N's biggest underlying challenge concerns the proliferation of digital books. Its 2011 Annual Report said it best by noting that "readers are flocking to our stores to browse for books they'd like to download, and while there we have the opportunity to sell them books and other merchandise." The irony is that this statement was offered as evidence of the company's inroads into the digital marketplace, which it claims to control a quarter of. What it suggests to me, however, is that customers see its stores as showrooms, more analogous to a library than a profitable enterprise.

The net result of these effects has left B&N struggling for survival. And nothing is more indicative of this than its tangible book value. While the company claims $760 million in shareholders' equity on its balance sheet, $1.1 billion of its assets consist of non-marketable intangibles such as goodwill, leaving the company with a negative tangible book value of $340 million.

Is this the final chapter?
The answer to B&N's problems is simple in theory yet challenging in execution. For the company to survive, it must unwind its traditional brick-and-mortar business in favor of its division. The problem is that the traditional Barnes & Noble retail locations account for 48% of the company's revenue while accounts for only 11%. And time is not on the bookseller's side, as its cash reserves and ability to borrow could force its hand in a matter of years if not months. While there's no question that the company gets this -- why else would it have switched to a nonretail, technology-based executive as CEO in 2010? -- managing this transition while the company is still liquid and solvent could be an insurmountable task.

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Foolish contributor John Maxfield does not have a financial stake in any of the companies mentioned above. The Motley Fool owns shares of, lululemon athletica, and Apple. Motley Fool newsletter services have recommended buying shares of, Apple, and lululemon athletica. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 04, 2012, at 1:20 PM, foolindeed1 wrote:

    Fool's analyst are known for hating BKS and loving AMZN thus I'm not surprised at all to see yet another poison-filled write up here. Yes, BKS invests all it makes (and more) from the stores into its fast growing digital business - last time I checked you no problems with AMZN doing exectly the same. Will have to wait and compare AMZN and BKS 4th quarter results - most analysts expect AMZN to miss estimates and post a loss while BKs to beat estimates and to be profitble by 2013.

  • Report this Comment On January 04, 2012, at 2:01 PM, JohnMaxfield37 wrote:

    foolindeed1 -

    I can't speak for my fellow Fools, but you're exactly right, I'm bearish on B&N.

    What analysts say means virtually nothing to me. By that logic, Enron would have been a "buy" a mere weeks before its collapse.

    Don't get me wrong, I love books, and I'm probably at B&N three to four times a week. But my subjective feelings doesn't change the reality of the situation. The company is on the verge of collapse. The stores can't compete. They sell books for 30% to 40% more than - not to mention itself! Meanwhile its gross margin is tanking. The status quo is simply unsustainable.

    While I agree with B&N's strategy to emphasize its digital division while de-emphasizing its stores, my reading of their financials convinces me that they made the transition too late. In the best case scenario, someone comes in to buy that division, but how could B&N's board justify selling it; it's the only part of the company with a future.

    What I didn't discuss at length in the article but is of equal concern, is the insider transaction between B&N and Riggio for the college division. I can't get my mind around how the board justified the $500 million price tag given that it consisted of hundreds more physical locations. Not a lot has been written about this, but I think it presents a number of interesting questions. And if nothing else, it's made me further question the strategic independence and direction of the leadership.

    At the end of the day, foolindeed1, I stand ready and willing to be convinced otherwise. But I simply don't see much evidence for the alternative you're implying.


  • Report this Comment On January 04, 2012, at 3:37 PM, leonhart03 wrote:

    You neglected to mention that their earnings are slowly but surely rising. If the pace continues to increase, we'd be seeing a positive return in the next year or so. Sure, winding down some underperoforming stores might be a good idea, but the big factor that supports BN's thriving nook business is that there are stores all over the nation where people can get personal service if they have questions or issues about their device. This has been a big reason people are choosing nook over kindle. If they get rid of too many stores, they risk alienating the local customer base they have fought to maintain.

  • Report this Comment On January 04, 2012, at 4:04 PM, JohnMaxfield37 wrote:

    leonhart03 -

    Having stores has helped B&N sell Nooks. There's no doubt about that.

    But even a "thriving Nook business" doesn't justify the square-footage of their stores. While providing "personal service" to customers with questions about their device is a nice thing to do, it doesn't pay the bills.

    And that's not where B&N makes its money anyways. It makes money selling books. Million and millions of them. Those sales are what pays the rent. And all of those sales are being aggressively pushed online -- by B&N itself, no less -- which eliminates the need for stores of that size and makes them unaffordable.

    Not to mention, to say that earnings are rising is slightly misleading. On an annual basis, they've fallen each year since 2007. And while they've slowly gotten less worse over the last few quarters, they are still negative.

    Look, I agree completely with your sentiment toward bookstores. But the fact of the matter remains, they aren't a viable business model any longer. And B&N is too deep into them to dig itself out.


  • Report this Comment On January 04, 2012, at 10:58 PM, FoolsAreTools wrote:

    I hope the author understands how tedious the repetitious speculative lambasting of B&N is on this website. (Meanwhile, the anti-B&N authors simultaneously shill a predictable handful of hyped up momentum stocks ad nauseum--stocks that are (coincidentally?) owned by the Motley Fool.

    Let's see some original thinking for a change instead of predicting doom for one of the most heavily shorted stocks in America.

    Rather than roll over and die, it's quite possible that B&N will right-size the physical bookstore and college bookstore venues, grow its market share in e-books, and probably come up with a few surprises in the next few years. Amazon faces the termination of the state sales-tax loophole, and they'll soon see increased investor pressure to turn money-losing revenues into profits. Both will pressure margins and improve the strength of tax-paying competitors, like B&N.

  • Report this Comment On January 05, 2012, at 12:23 PM, ScotchIrishPrinc wrote:

    "They can sell everything cheaper, ship everything to the customer's door instead of to much fewer fixed locations (stores), sell millions of Kindle "Fires" at a loss, open more and more of these "fulfillment centers" that each have many of the same expenses stores have…"

    They sell Fires at a $2 loss. That's nothing when you look at how much content the customers who bought them will buy over the next few years. Yes, they have local shipping options, but a lot of those are subsidized by the millions of people who subscribe to Amazon Prime for $80/year AND pay $4 per item for same/next day delivery. Their warehouses are located in industrial parks that have much cheaper rent per foot than retail locations and employ fewer people.

    Obviously, their advantage is based on lower overhead and the lack of a sales tax. The latter will get remedied in the coming years, but Amazon will still have better prices than B&M's. There are also thousands of merchants and second hand retailers selling through Amazon, all of which pay a fee to Amazon. Then there is the foray into shoes,, their high fashion site, and of course, E-Books.

    Amazon will have to make changes in the coming years to maintain their position and they aren't perfect, but to compare them to Enron and Worldcom is foolish—and not the kind this site professes.

  • Report this Comment On January 06, 2012, at 12:04 PM, ScotchIrishPrinc wrote:


    I feel your pain. I enjoy wandering through book stores as well. There is just something about them that feels so much nicer than libraries. The local Borders shut down and now the closest book store is the rummage-sale-esque Books-a-Million or the B&N thirty minutes away. If BN closes stores, which is likely over the next few years, consumers will be left with Target and Walmart as the primary places to "see" books, which is really depressing.

  • Report this Comment On January 06, 2012, at 4:26 PM, FoolsAreTools wrote:

    The article relies on the usual coffeeshop doomsday theories about Amazon and ebooks killing B&N in blitzkrieg like efficiency. It shows an annoying lack of knowledge of B&N operational details.

    1. There is no solvency/liquidity issue. (Examine the B&N financing/credit arrangement in detail to understand your error.)

    2. The B&N books stores are not the source of quarterly losses dragging down the Nook & e-book business. It's the other way around. The Nook & e-book business is killing the EBITDA of the physical bookstores.

    3. Nowadays B&N is often the only game in town for the many people who like bookstores. The bookstores do have earnings and will likely be even more profitable as B&N finds the optimal store footprint. Not everyone is a geek who wants to live life through a computer. Some people actually like to leave their rooms when they shop. This must be hard to believe for the types of guys who write articles for the Fool.

    The biggest difficulty for B&N is the technology side of the company. It's a high-stakes gamble for any company to succeed in this arena. So far, B&N's e-business is doing better than many larger competitors.

    B&N's e-biz will make a nice plug-in for a large company (Google, Sony, or ??). If and when B&N spins off the Nook division, shareholders will likely double their money on their original B&N investment at the current $11 stock price.

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